CC BY
105
Экономические науки
Donka Andreeva
Assoc. Prof. , Ph.D, University of National and World Economy, "Industrial Business" Department
Воитлева З. А.
к. э. н., доцент ФГБОУ ВПО «Майкопский государственный технологический университет», г. Майкоп
Главина С. Г.
аспирант РУДН, кафедра международных экономических отношений
Григорян Е.С.
к.э.н., доцент кафедры экономики и менеджмент, ПензГТУ, г.Пенза
Клименко И. С.
аспирант кафедры экономики социальной сферы МГУ имени М.В. Ломоносова
Купцова А. А.
University of Pardubice Jana Pernera Transport Faculty Departments of Transport Management, Marketing and Logistics
doc. Ing. Petr Prusa, Ph.D
University of Pardubice Jana Pernera Transport Faculty Departments of Transport Management, Marketing and Logistics, Научный руководитель
Ларионова И.Г.
соискатель кафедры мировой экономики и менеджмента КубГУ, г. Краснодар
The Role Of Business Valuation For The Financial Management Of Industrial Companies
Donka Andreeva
Abstract:
The approaches and methods for business valuation of industrial companies, related in a specific way in a methodology, are the focus of this article. These approaches and methods are increasingly attracting attention, especially the attention of financial management, due to the constant need for specifying the value of the industrial company and of its business respectively, currently, as well as in the future.
The methods for business valuation of the industrial business company are illustrated by practical examples and applicable approaches and methods are shown.
In this article the author aims to reveal the essence and need for business valuation, to discuss the types of methods and to dwell on some considerations.
Keywords:
business valuation, net worth method, cost approach, liquidation value method, comparative approach, discounted, cash flow method, profit approach
Introduction
The dynamics of the financial system, the complexity of the financial relations of industrial companies and their management make it necessary to use a combined approach to business valuation.
The role of business valuation for financial management is in the valuation of the company, respectively of its business, while considering both its current financial situation (value of fixed assets, value of cash flows, financial results, etc. ) and assessing the prospects for development of the company and its business.
1. Essence and importance of business valuation
In valuation theory and practice1 along with „company valuation”, also used is the term “business valuation.” The two terms are similar, but there is a difference between them, the reasons for this being the following:
In company valuation is determined the value of shareholding in the capital or the value of the equity ownership of a going industrial concern for profit.
In business valuation are evaluated specific fields of the business of the company, not the legal entity. Production fields become independent business when restructuring of the company is undertaken, also change of the scope of work, business combinations, etc. In these cases the financial manager and the shareholders need to assess the value of these fields — to assess the value of the property complex of the industrial company, the whole of it or some part of it.
It is appropriate to combine company valuation and business valuation under the common term of “business valuation.” Business valuation is a focused and consistent process of assessing the value of the company and determining its value in monetary terms, while taking into account the potential and real income that this entity could bring within the specific period and in the specific market. The essence of business valuation is to determine the value of the company as a separate economic system which continues its operation and is expected to generate cash flows in the future.
2. Need for business valuation
Most often such a need arises in connection with:
• Determining the fair market value of the company as the
1. Kasurova, V. "Valuation of Trading Companies and Receivables", NBUiS.i2011ip.5-8
Экономические науки
basis for developing an offer in mergers, acquisitions, remergers, restructuring, remediation.This valuation is used in privatization and liquidation.
• Identifying the contribution (input) ofthe company injoint ventures.
• Setting the price of securities at their issuing and the listing of the company on the stock exchange. The valuation of the company in this case allows to determine the market value of its equity, the value of a share and a block of shares, as well as the future earnings from holding those assets (in this case, however, must not associate with the term “balance”, defined as “the maintenance of equilibrium in terms of material, monetary and labor resources”). [6, p. 47]
• Determining the value of business strategies for the launching of new products, agreeements for joint ventures, for entering new markets.
• Determining the creditworthiness of companies and the value of pledged property in bank lending
3. Components of business valuation
• fair market value (price) - the price at which a specific company/asset can be sold, combining the interests of both parties and each of them. The information relates to the analysis of the possibilities of the company.
• investment value — it considers the ratio of risk and return. In this case we must consider the dynamics of inflation, the trend in interest rate, etc..
• accounting book value of the company and items - formed by the actual accounting data such as the balance sheet, the income statement and other documents, related to the assets of the business.
• share value — it is closer to the real one.
• liquidation value — at the sale / liquidation of the company and all its assets
4. Valuation methodology
Methodology is a system of approaches and methods of business valuation, related in a specific way.
With business valuation the practice is to use three separate approaches. Each approach and method in business valuation focuses on a specific aspect of the potential of the company for financial management and successful business. As a complex term business success depends on various factors - financial and non-financial. It can fully and precisely be assessed only after a complex valuation, by applying different approaches and methods of analysis ..
Each of the approaches is realized through specific methods. A method is a specific procedure within one approach for determining the value.
A. Cost approach
It is a way of determining the value of the assets of a business or sharesholding through the following methods:
The net worth method.
It is the difference between the adjusted assets of the company and its adjusted liabilities.
fixed assets — 85 000 common capital — 75 000
inventories — 25 000 reserves — 23 000
short-term receivables — 12 000 financial result — 7 000 cash — 9 000 long-term liabilities — 22 000
short-term financial assets — 8 000 insurance institutions liabilities — 3 500
adjusted assets = 139 000 Payables to employees — 4 500
= adjusted liabilities 2= 32 000
2. The adjusted liabilities do not include fixed capital, reserves, financial result, which are in the section of the balance sheet capital
Net asset value = Fair market value (adjusted assets) - Fair market value (adjusted liabilities) =
139 000 - 32 000 = 107 000
If the company is a joint-stock one, the value of its shares is calculated by this method by dividing the market value of equity by the number of shares in circulation.
The liquidation value method.
The liquidation value method is applied in general in the valuation of companies, and in particular of industrial companies in liquidation or of the property of already liquidated companies. The value, determined by this method, is assumed to be the lowest possible price of the assets of the valued company.
To determine the liquidation value of the company the following formula is used:
LV = ALV- VL- LC where:
LV is the liquidation value of the company;
ALV — the liquidation value of the assets of the company;
VL — the value of the liabilities.
LC - the liquidation costs.
The liquidation value of assets is affected by the period of liquidation. In short periods of liquidation (6-8 months), the deviation of the liquidation value of an asset may reach 30-40% below the market value of that asset for a going concern.
B. Comparative approach
It is a way of determining the value of an industrial company or shareholding in it by methods that compare it to an analogous entity. Methods for applying the comparative approach:
• The capital market method.
• The transaction value method
• The industry ratios method
The method that is most commonly used is the transaction value method. Market value is determined based on the analysis of the prices of transactions carried out with similar businesses.
To carry out valuation by this method, the following procedures are applied:
• Choice of analogous (similar) companies
• Determination of market multipliers for the analogous company.
• Determination, by means of the market multiplier, of the fair market value (FMV) of the company as a whole or of the controlling interest.
Analogous companies should be comparable in essential characteristics to the valued company. The analogue is selected by criteria, such as type of activity, type of manufactured products (services), size of company, size of profit and paid dividends, position in the industry, stage of development (stage of the life cycle), management structure, capital structure, balance sheet value, credit status.
B. Profit approach
The idea behind the profit approach is to discount the forecasted profits (cash flows) by an appropriate discount rate back to the present value.
The method, used by the author in the following survey, is the method of discounted cash flows, with which the value of a company is divided into forecast value and after-forecast (terminal, residual) value.
In theory there are several variations of the model of discounting of the free cash flow, suitable for use at the various life stages of the industrial company.
• One-stage (or basic), applicable with a steady growth of the company.
Всероссийский журнал научных публикаций № 4(19) 2013
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• Two-stage, used in a combination of accelerated growth in the initial stage of development with a stage of steady growth, which in itself is Gordon’ s model.
• Three-stage, combining a high growth stage, a transition period and a stage of steady growth.
The following valuation uses a two-stage model, anticipating dynamic growth for the period from 2013 to 2018 and steady growth from 2018 on.
Cash flows are forecast for the period 2013 — 2018. This period starts from the date of valuation and is called the forecast period, and the resulting value — forecast value, correspondingly. The present value of cash flows is calculated using the following formula3: where:
is the present value of a cash flow for period “n”;
— the net cash flow for the same year;
— the discount rate;
— the consecutive year of the forecast period.
According to other authors4, the resulting present value of cash flows should be adjusted by multiplying it by the so-called “average annual adjustment factor” It is calculated thus: where:
MYAF is the average annual adjustment factor r — the discount rate.
The present value of cash flows for the forecast period is multiplied by the average annual adjustment factor (MYAF), i.e.
This formula is not used by the author in the practical examples.
The after-forecast period starts from the end of the forecast period and is unlimited in time. The valuation of this period is called after-forecast (terminal) value of the cash flow.
Terminal value is the value of the company in stabilized conditions, which are expected to be constant in the future. It is assumed that the cash flows will grow at a steady rate. The terminal value is calculated in accordance with Gordon’s model by the formula5:
And its discounted value at the time of valuation, correspondingly: where:
is the terminal value of the company;
is the cash flow for the last year of the forecast period;
r — the discount rate;
g — the annual growth of the cash flow in the after-forecast period;
n — the last year of the forecast period.
In accordance with the model of the free cash flows the cost of capital is the present value of the cash flow year by year of the forecast period plus the present value of the terminal value of capital at the end of the forecast period:
The discount rate is a complex quantity that summarizes the impact on valuation of parameters that take into account the risk in such an investment. It is calculated by the method of cumulative risk (build-up approach). Moreover, the discount rate of net cash flows is the sum total of the following components: r = Rf + Re + Cs,
3. Petrov,G.et al, Corporate Finance,p.35
4. Copeland,T., T.Koller, J.Murrin,"Measuring and Managing the Value of Companies, John Weley&Sons,N.Y.,2000,p.294
5. Georgiev,I. et al, Economy of the Company, "Economy" University Press,S.,2008,p.373
where:
Rf is the return on risk-free investment;
Re — the additionally required return (risk premium) on the capital market;
Cs — the additionally required return (premium) to invest in
the particular company.
Example: The discount rate is assumed to be 13 %
Years (n) 1 2013 2 2014 3 2015 4 2016 5 2017 6 2018 Total
Projected cash flows 10 000 15 000 20 000 25 000 30 000 35 000
Discount % (r) 13 13 13 13 13 13
(1+r)n 1.13 1.28 1.44 1.63 1.84 2.08
Net present value 8 850 11 747 13 861 15 332 16 283 16 811 82 884
For the calculation of the terminal value of the company we assume that in the after-forecast period (from period 6 onwards) the cash flow has a constant growth rate of 2% annually.
V = 82 884 + 155 885 = 238 769
This is the value of the company as a whole. To calculate the value of capital, we must subtract the adjusted liabilities and add cash (from the example of the net asset value, the method of the net value of liabilities).
The valuations, calculated by the relevant methods, should be compared with fixed ones from research of financial and analytical, as well as with valuations of competing companies in the relevant industry, in order to find the fair value of the company. For this purpose similar factors can be taken for the weight of each of the two valuations by the two relevant methods:
Methods Valuation Factor Real value
Net asset value 107000 0.6 64 220
Discounted cash flows 215 769 0.4 86 308
Total weighted price 150 528
The fair value of the assets of the company with the determined weights of the relevant methods is 150 528 Levs
The use of more than one valuation method relults in a range of values. Because of the limitations of each of the methods, used for business valuation, practically valuations should be carried out by at least two of them and at the discretion of the valuer the weighted average of their results be determined. Thus, the disadvantages of each of the methods, used for business valuation, are eliminated to some extent.
The role of business valuation for the financial management of the industrial company consists in changing the belief of managers themselves that the assessment of the value of their business is an expression of the quality of their management.
References:
1. Balabanov, I.T. Fundamentals of Financial Management. How to Manage Capital? - Finance and Statistics, M., 1996
2. Georgiev, I. et al., Economy of the Company, "Economy" University Press, S., 2008
3. Kasurova, V., Valuation of Trading Companies and Receivables, NBU, S., 2011
4. Petrov, G, et al.,. Corporate Finance, short course, 2nd revised edition. - Trakya -M, S., 2006.
5. Copeland, T., T. Koller, J. Murrin, "Measuring and Managing the Value of Companies", John Weley & Sons, N.Y., 2000
6. Velkovska G., Collection of education tests of regional economy, Valdes - VV - GV, S., 2012.
7. www.bgbusinesshelp.com
8. http://eprints.nbu.bg/515/1/Ocenka_obshto.pdf
